Fixing the Euro Would Be Cheaper Than Germans Think

Aug. 8 (Bloomberg) -- Germany’s leaders are loath to do
what it takes to save the euro, in large part out of the not
unreasonable fear it will cost their country too much.

By our calculations, their concerns are misplaced.

Time and again, efforts to contain Europe’s worsening debt,
banking and economic crises have run into the same obstacle. Any
credible solution requires a commitment by euro-area governments
to back one another’s debts and help one another through hard
times. Yet the wealthier countries, and Germany in particular,
reject measures that hint at transfers of money -- instead of
loans -- to struggling states such as Greece and Spain. They
assume they would be dragooned into supporting weaker economies
forever.

It’s easy to understand why the Germans are worried. The
experience of the U.S., the world’s largest currency union,
suggests fiscal transfers can be very expensive for individual
members of the union. The relatively affluent state of
Connecticut, for example, has in some years sent as much as 8
percent of its gross domestic product to poorer states. The
payments, made largely through the federal income tax system,
serve both to equalize levels of income across the U.S. and to
cushion regional downturns. States in recession, for example,
receive transfers large enough to offset as much as 40 percent
of their loss in income.

Risk Sharing

Like it or not, the euro area will need a similar risk-sharing system. Economists have long warned that the member
countries’ economic cycles are too far out of sync to coexist
without some kind of stabilizing mechanism. Inflation and
unemployment rates diverge wildly, and European workers aren’t
mobile enough to compensate by moving to where the jobs are.

So what would it cost to turn Europe into a better fiscal
union? Let’s try a thought experiment.

The first step is to figure out what kind of fiscal
transfer system best suits the euro area. Equalizing income
levels need not be the goal -- trade and investment can play
that role. What matters for the currency’s viability is
diverging growth rates. So, the transfers should be aimed at
smoothing them out.

To get a sense of how this could work, imagine a fictional
European Stabilization Fund. Countries experiencing relatively
fast growth (more than 2 percent, adjusted for inflation) would
contribute to the fund. Countries in recession would receive
payments equal to 40 percent of their loss in income, a cushion
at least as generous as that in the U.S. If the 12 countries
that have been in the euro since 2001 all participated in such a
fund, how would it have worked out?

Based on the economic performance of the 12 countries, it’s
possible to come up with an answer. The results are surprising.

From 2001 through 2012, a period that included one of the
worst recessions on record, the contribution required from the
fast-growing economies to keep the fund above water would have
been only 0.64 percent of their gross domestic product. Germany
grew fast enough to qualify as a contributor in only four of the
12 years, so its average payment would have been a meager 0.03
percent of GDP -- a total of about 11 billion euros for the
whole period. In the recession year of 2009, Germany would have
received a stimulus equal to 2 percent of GDP, more powerful
than the program the U.S. put in place that year.

Spain, not Germany, would have been the biggest net
contributor in euro terms, putting in more than 14 billion -- a
function of its real-estate boom in the first part of the
decade. France would have come in second at nearly 13 billion
euros. Greece would have been a contributor in most years;
ultimately, it would have received a net 5 billion euros, mostly
in 2011, a year it desperately needed the help.

Mitigating Booms

In other words, history tells us there’s no reason to
believe that a deeper fiscal union would entail constant support
from Germany to peripheral countries such as Greece and Spain.
Money would flow in all directions, and the transfers could go a
long way toward mitigating booms and busts.

Starting such a fund today would not be much more difficult
than it would have been in 2001, even though harsh austerity
measures have snuffed out growth in most of the euro area. Based
on the International Monetary Fund’s growth forecasts, a newly
created stabilization fund would have to borrow about 10 billion
euros to cover payments for this year and next. It would have
enough contributions to pay the borrowed money back by 2015.

The exact cost and impact, of course, would depend on how
European leaders chose to design the transfer mechanism. We
favor a euro-area unemployment-insurance fund, which would make
payments directly to the jobless in hard-hit countries. In
return, workers could be required to sign more flexible
employment contracts, encouraging the kind of labor-market
reforms needed to make the region’s struggling economies more
competitive. Such a mechanism, according to one of its
designers, Jacques Delpla of France’s Conseil d’Analyse
Economique, might cost as much as 1 percent of GDP for
contributing countries.

Fiscal transfers aren’t the only form of risk-sharing
needed to make the euro area work. To get past the current
crisis, euro-area nations must also take on some collective
responsibility for government debts, a move that would probably
require Germany to pay a higher interest rate on its portion of
the debt. Here, too, Germany’s burden might not be very large. A
European Commission report, for example, suggests the country’s
borrowing costs could be about half a percentage point higher.
On a German net debt load of about 2 trillion euros, that
amounts to 10 billion euros a year, or 0.4 percent of GDP.

There were signs this week that a shift might be taking
place in Germany. On Monday, the opposition Social Democratic
Party signaled its support for a tighter fiscal union. The move
was an acknowledgment of something that’s been too clear for too
long: The euro area’s approach to solving its problems isn’t
working. European governments and the ECB have lent more than 2
trillion euros to support struggling member countries, while
imposing austerity measures that are serving only to make the
situation worse. If the euro falls apart, they stand to lose
much of that money. Doing what it takes to make the currency
union viable looks like a much better option.

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